Trading Venues Research Articles

Market Design—A Practitioner’s Perspective

Financial markets have fundamentally changed with the application of information technology. Market development has changed accordingly. It has become a design process; it moved into the focus of market design. The objects of market design are market models, trading services, and trading systems—their analysis, description, and specification. Market design refers to and is guided by market microstructure with its market model schemes and classifications, market-model-related findings, and results on topics of market liquidity. Market design as an approach for market development is applied by market operators who as a business build and run trading systems. Xetra, a trading system, has been operated by Deutsche Börse since 1997 and is the leading trading venue for German equities and exchange-traded funds in Europe. Some key concepts and innovations of Xetra are shown and explained as example cases for market design in this article: how market model schemes, different measures of liquidity management, and modification and extension of the hybrid market model contributed to the success of Xetra over many years.

When Does The Tail Wag The Dog? Curvature and Market Making

Liquidity and trading activity on constant function market makers (CFMMs) such as Uniswap, Curve, and Balancer has grown significantly in the second half of 2020. Much of the growth of these protocols has been driven by incentivized pools or 'yield farming', which reward participants in crypto assets for providing liquidity to CFMMs. As a result, CFMMs and associated protocols, which were historically very small markets, now constitute the most liquid trading venues for a large number of crypto assets. But what does it mean for a CFMM to be the most liquid market? In this paper, we propose a basic definition of price sensitivity and liquidity. We show that this definition is tightly related to the curvature of a CFMM's trading function and can be used to explain a number of heuristic results. For example, we show that low-curvature markets are good for coins whose market value is approximately fixed and that high-curvature markets are better for liquidity providers when traders have an informational edge. Additionally, the results can also be used to model interacting markets and explain the rise of incentivized liquidity provision, also known as 'yield farming.'

Regulation of Algorithmic Trading: Frameworks or Human Supervision and Direct Market Interventions

This paper identifies the regulatory gaps that currently exist in algorithmic trading and provides a framework for machine learning regulation in finance. It compares the regulation of algorithmic trading in the capital markets by both human supervision and direct market intervention in the UK, the EU and the US to identify techniques they have in common, as well as local differences. Section II sets out what algorithmic trading is, how it is defined, which of its functions have a positive effect and which are negative for risk and impact. Section III examines how trading risks can be managed by human supervision. Section IV looks at how direct market intervention can mitigate the risks of algorithmic trading, focusing on the circuit breaker requirement. Finally, the liability of the parties involved (traders, firms, and trading venues) are examined and the possible enforcement actions that regulators may take are set out. Algorithms, high frequency trading, machine learning, financial regulation, MIFIDII, ESMA, FCA, SEC, circuit breaker, systemic risk

Dynamics in futures and spot markets: A panel study of advanced and emerging economies of Asia

The study explores the underpinning interlinkages in the spot and futures markets across nine Asian advanced and emerging economies, and examines whether development status has any impact on the nature and speed of adjustments in the information transmission. By applying Panel VECM to the data set from the very day futures trading was initiated on the respective exchange till February 2020, the results highlight that in the long run, over the entire period, the futures market adjusts 69.7% more than the spot market and there is a bidirectional causality in the short run. Even in the sub-periods, the same phenomena were observed, and in the short run, there was a unidirectional causality from futures to spot during the crisis period. An identical trend was observed for country groups in three sub-periods. However, in the short run, during the crisis period, a unidirectional causality from futures to spot was found in advanced economies, while the opposite pattern was found in emerging economies. The paper establishes that the spot market dominates the information dissemination process. The results also demonstrate that traders prefer liquidity over leverage as their trading venue, the existence of potential index arbitrage opportunities, and validate that development status has no impact on the information transmission pattern amongst the markets, except during turbulent times. The study offers insights to market participants to develop their specific trading strategies in these markets at various economic stages, thereby increasing their expected returns.

Strengthening the Treasury Market

For more than 200 years, the market for U.S. Treasury securities has propelled U.S. economic success. More recently, it has been described as the world’s most important financial market because Treasury securities promote liquidity, price discovery, and economic stability across the globe. Despite its vital role at home and abroad, the Treasury market lacks certain structural protections that are common in other advanced financial markets. Bringing the Treasury market into the modern age is necessary because it is not immune to the risks that confront other financial markets. This was underscored in early 2020, when the coronavirus (COVID-19) pandemic roiled the Treasury market, producing significant trading disruptions and liquidity constraints. 
 To help reduce the risk of future Treasury market instability, this Article recommends modest enhancements that have proven successful in similar markets. Robust public reporting of Treasury securities trades, improved oversight of trading venues, safeguards that promote operational resiliency, and expanded central clearing will promote Treasury market strength and resiliency well into the future.

The complex nature of financial market microstructure: the case of a stock market crash.

This paper uses multivariate Hawkes processes to model the transactions behavior of the US stock market as measured by the 30 Dow Jones Industrial Average individual stocks before, during and after the 36-min May 6, 2010, Flash Crash. The basis for our analysis is the excitation matrix, which describes a complex network of interactions among the stocks. Using high-frequency transactions data, we find strong evidence of self- and asymmetrically cross-induced contagion and the presence of fragmented trading venues. Our findings have implications for stock trading and corresponding risk management strategies as well as stock market microstructure design.

A new piece in the puzzle of locating financial loss: the ruling in VEB v BP on jurisdiction for collective actions based on deficient investor information

For the first time, the CJEU has ruled in VEB v BP on the court competent for deciding liability suits regarding misinformation on the secondary securities market. Surprisingly, the Court localises the damage resulting from misinformation on the secondary financial markets at a single place, that where the financial instruments in question were listed. This raises the question of how the decision can be squared with earlier cases like Kolassa or Löber and other precedent. It is also unclear how the new ruling applies to special cases like dual listings or electronic trading venues. Furthermore, the judgment is of utmost importance for the jurisdiction over collective actions by postulating that they should not be treated any differently than individual actions, without clarifying what this means in practice. This contribution analyses these questions, puts the judgment in larger context, and discusses its repercussions for future cases.

Over-the-counter market and corporate bond market development

The objective of this paper was to empirically investigate the factors of corporate bond market development for a sample of emerging and developed countries over the period 2008-2017. Here, we used both fixed effect and Prais-Winsten methods to study the determinants of corporate bond market development. We document a negative and significant relationship between primary market issuance and the over-the-counter (OTC) secondary corporate bond market that can be explained by the inefficiency of the OTC corporate bond market and the lack of trade transparency for this trading venue. We suggest that these microstructure elements of the OTC secondary market harm the corporate bond market development and thus discourage corporate bonds issuance. Furthermore, we provide strong evidence of the relationship between economic growth, domestic credits, corruption and the issuance of the domestic corporate bond market.

Ecological and Coevolutionary Dynamics in Modern Markets Yield Nonstationarity in Market Efficiencies

The U.S. stock market is one of the largest and most complex marketplaces in the global financial system. Over the past several decades, this market has evolved at multiple structural and temporal scales. New exchanges became active, and others stopped trading, regulations have been introduced and adapted, and technological innovations have pushed the pace of trading activity to blistering speeds. These developments have supported the growth of a rich machine‐trading ecology that leads to qualitative differences in trading behavior at human and machine time scales. We conduct a longitudinal analysis of comprehensive market data to quantify nonstationary dynamics throughout this system. We quantify the relationship between fluctuations in the number of active trading venues and realized opportunity costs experienced by market participants. We find that information asymmetries, in the form of quote dislocations, predict market‐wide volatility indicators. Lastly, we uncover multiple micro‐to‐macro level pathways, including those exhibiting evidence of self‐organized criticality.

Generalized optimal liquidation problems across multiple trading venues

<p style='text-indent:20px;'>In this paper, we generalize the Almgren-Chriss's market impact model to a more realistic and flexible framework and employ it to derive and analyze some aspects of optimal liquidation problem in a security market. We illustrate how a trader's liquidation strategy alters when multiple venues and extra information are brought into the security market and detected by the trader. This study gives some new insights into the relationship between liquidation strategy and market liquidity, and provides a multi-scale approach to the optimal liquidation problem with randomly varying volatility.</p>

The unintended consequences of the regulation of cryptocurrencies

AbstractThis paper investigates whether the application of the latest guidance of the Financial Action Task Force (FATF) for regulating cryptocurrencies may engender unintended consequences at odds with the initial purposes of transparency and technology neutrality. For instance, we will ask whether regulation strengthening may incite a category of investors to flight to unregulated and non-compliant decentralised exchange platforms to stay under the radar of regulators. Furthermore, we ask whether regulation may lead to a two-tier industry, fragmented between compliant trading venues that attract mainstream users and non-compliant trading venues that attract privacy-centric users. We argue that somewhat paradoxically, regulation may push part of the crypto-industry to the ‘dark side’ of financial innovation and drives privacy-centric investors out of the scope of regulators.

Order Routing Decisions for a Fragmented Market: A Review

This paper reviews the up-to-date theoretical, empirical, and experimental literature related to the trading venue choice in the context of the fragmented equity markets. We provide a brief background on the history of trading fragmentation in the equity market and its determinants. We discuss the direct and indirect impacts of the market fragmentation on market quality in various dimensions, including liquidity, volatility, and price efficiency. Next, we identify possible determinants and channels from theoretical and empirical studies that could explain order routing decisions and present the possible directions for future research. Finally, we discuss the major regulatory reforms in the U.S. equity market on routing venue decisions. This topic is relevant in current times when phenomena such as “GameStop Frenzy” have drawn significant attention to commission-free trading venues.

Intraday volatility smile: Effects of fragmentation and high frequency trading on price efficiency

In 2007, the European Markets in Financial Instruments Directive ended the national concentration rule. As a result, market fragmentation has accelerated across multiple trading venues. Spatial fragmentation might create opportunities and incentives for High Frequency arbitrageurs to fill the void left by the lack of Reg NMS type order routing requirements in Europe, without neglecting market integrity. This paper examines intra-day volatility and price efficiency through the metric of the normalized volatility ratio for the years 2006, 2012 and 2013 for Euronext Paris, BATS and Chi-X Europe. Our findings show that price determination remains inefficient at market opening due to the complexity of price discovery activity following a period of non-trading and heavy information releases. However, we demonstrate that an active participation of high-frequency traders significantly improves market efficiency at opening session.

Multi-party computation mechanism for anonymous equity block trading: A secure implementation of turquoise plato uncross.

Dark pools are financial trading venues where orders are entered and matched in secret so that no order information is leaked. By preventing information leakage, dark pools offer the opportunity for large volume block traders to avoid the costly effects of market impact. However, dark pool operators have been known to abuse their privileged access to order information. To address this issue, we introduce a provably secure multi-party computation mechanism that prevents an operator from accessing and misusing order information. Specifically, we implement a secure emulation of Turquoise Plato Uncross, Europe's largest dark pool trading mechanism, and demonstrate that it can handle real world trading throughput, with guaranteed information integrity.

The evolution of price discovery in an electronic market

We study the evolution of the price discovery process in the euro-dollar and dollar-yen currency pairs over a ten-year period on the EBS platform, a global trading venue used by both manual and automated traders. We find that the importance of market orders decreases sharply over that period, owing mainly to a decline in the information share from manual trading, while the information share of market orders from algorithmic and high-frequency traders remains fairly constant. At the same time, there is a substantial, but gradual, increase in the information share of limit orders. Price discovery also becomes faster, suggesting improvements in market efficiency. The results are consistent with theoretical predictions that with a lower information advantage, informed traders tend to use more limit orders.

“The best of all possible worlds”? The access of SMEs to trading venues: Freedom, conditioning and gold-plating

According to Gottfried Wilhelm von Leibniz (Leipzig, 1646 - Hannover, 1716), we live in the best of all possible worlds. The giant of French philosophes, Voltaire, had a different view: in his novel Candide (1758), the disillusioned protagonist ends up with a different, anti-idealistic view. The landscape of EU capital markets legislation looks, at times, closer to the world of Voltaire, than to that of Leibniz. This is particularly the case of the rules that apply to SMEs wishing to access trading venues: a topic of paramount importance in the context of the burgeoning debate on the need to foster and accelerate the development of EU Capital markets. Pragmatism, case-by-case approach, absence of a truly systematic view seem to be the rule. Companies, and especially SMEs, that access trading venues in the EU are confronted with a complex, jagged and articulated regulatory horizon. This paper confronts the rules applicable across different MTFs in a number of jurisdictions, setting out their basic features, and the level of constraints, or freedom, that they imply for companies wishing to access them. The latest evidence provided by ESMA indicates more than 74% of issuers with shares traded on European trading venues are SMEs: a striking figure, such as to stimulate, per se, a new critical, wide debate on the current structure of capital markets regulation in Europe, well beyond the rules applicable in the context of trading venues. Capital markets legislation in the EU developed focusing on large, listed companies, whereby SMEs were seen as an exception, but, today, the reference framework has changed. The time, therefore, might be ripe for a radical re-thinking of the structure of such legislation, and the findings of this paper seem to point in that direction.

Does off-exchange trading decrease in the presence of uncertainty?

Much of the trading in U.S. equities has moved to off-exchange venues. This study examines the pecking order hypothesis of trade venue selection by analyzing the amount of off-exchange trade volume in periods of uncertainty. During the sample period, there were over two billion shares per day reported to the Nasdaq TRF-Carteret, which maintained more than 29 percent of the total market share of volume in U.S. securities. The TRF-NYSE captures more market share in Nasdaq-listed securities than NYSE-listed stocks. This study also sheds light on the introduction of the Nasdaq TRF-Chicago and its ability to attract volume. Ultimately, there is evidence that the amount of off-exchange volume decreases during periods of heightened volatility. The findings are of interest to market participants, exchange officials, and regulators.

International Review of Equity Market Structure Regulation: Phase III

International Review of Equity Market Structure Regulation: Phase III

Are Asian exchanges outliers? A market quality criterion

This paper provides a practical, empirical and theoretical framework that allows investment managers to evaluate stock exchanges’ market quality when choosing among different plausible international trading venues. To compare trading exchanges, it extends the hypothesis of market microstructure invariance to trading across exchanges. A measure ω, the ratio of the market-wide volatility to microstructure invariance, is introduced. The paper computes ω for the exchanges around the world. Its value for the NSE (India) is 24.5%, the Korea Exchange (Korea) is 7.9%, the Shanghai Exchange (China) is 3.5%, and the Shenzhen Exchange (China) is 4.4%, which is significantly different from that of major exchanges in the USA (NYSE – 0.8%, NASDAQ – 1.3%) and Europe (LSE (UK) – 0.4). This country risk dimension clearly identifies which equity exchanges cannot hold their own direct correlational hedges and therefore mandatorily require derivative positions, and has significant implications for the decision making of global long-short equity asset allocators in the Asian listed equity markets.

On Fine Wine Pricing across Different Trading Venues

AbstractThis article examines how selected attributes of Bordeaux fine wines (producer, vintage, quality, bottle size, case, flaws, and transaction volume) affect prices in three types of trading venues: auctions, electronic exchange, and the over-the-counter (OTC) market. The findings indicate a price differentiation across the venues. Wine aging leads to relatively higher prices at auctions than on the electronic exchange or the OTC. There is a nearly linear relationship between prices and wine ratings, the strongest of which is found in the case of auctions. The bottle size effect is mostly positive for supersized formats and is the strongest on an electronic exchange and the weakest at auctions. The transaction volume negatively affects wine prices in all the trading venues. The simulation results facilitate the construction of more realistic trading models and may help traders make more informed decisions on the choice of a trading venue, depending on the wine characteristics. (JEL Classifications: D40, G12, Q14, L66)